Ed Yardeni Likes Emerging Markets, High Yield Bonds; Believes Europe's in for Trouble

Ed Yardeni is president of Yardeni Research Inc., a provider of independent investment strategy research and data. He has worked as chief investment strategist at Deutsche Bank, Prudential Equity Group and Oak Associates. Yardeni has also served as chief economist for C.J. Lawrence, Prudential Securities and E.F. Hutton.

His resume also includes working as an economist with the Federal Reserve Bank of New York. He also held positions at the Federal Reserve Board of Governors and the U.S. Treasury Department.

Earlier this week, IndexUniverse.com's Murray Coleman caught up with the market-oriented economist and investment analyst to find out his take on macrotrends going forward.

IndexUniverse.com: Does this rally have legs?

Ed Yardeni: I think it does. It has already traveled a fair distance. I think 1,000 on the S&P 500 is likely. We're probably going to take-out the Jan. 6 high for the year fairly soon, which was 934.70.

IU: Do you see more bumps in the round?

Yardeni: Yes, but they're the same bumps we've seen in the bear market. The banking system still has its issues as evidenced by the most recent stress test given by the government. And unemployment is still a concern. But there's a sense that these problems might not stop the economy from recovering after all.

IU: Do you see a pullback coming, though?

Yardeni: I don't try to be a technician. But sure, there could be a pullback. Remember, though, that we're coming back from a huge fall. What is encouraging is that stock prices in many industries are gaining back their losses from the September 2008 levels. That's when Lehman and AIG really hit the fan and panic took over.

IU: What sectors seem the best-positioned at this point?

Yardeni: Being defensive doesn't make much sense with a global recovery in sight. So I think materials and industrials should do well. The price of oil has done well recently. It should continue to rise. In the next six- to 12-months, prices could get up into the $75-$80 per barrel range. The metals and mining as well as specialty chemicals also look attractive now. Diversified chemicals still appear rather sluggish and I don't see a lot of upside in that industry.

IU: Do you think gold has more room to run?

Yardeni: Not necessarily. Gold and the trade-weighted U.S. dollar have been flight-to-safety plays. We've seen more interest in risk-taking lately. If that continues to be the case, the trade-weighted dollar and gold may go nowhere fast. I'm not enthusiastic about either one at this point.

IU: How about emerging markets?

Yardeni: They've had a great run and I think they'll continue to outperform from here. We started to see at the beginning of this decade a great global boom. That was interrupted by the credit crisis, but it looks like global growth might be resuming again. China, India and Brazil look best at this point. Asia will be the region that really leads the global economy out of this recession, more so than the U.S., Japan or Europe.

IU: How do you see Europe?

Yardeni: It's going to be a slow-growth story. They don't have much going on over there in terms of domestic demand. The demographics are against them with an aging population. And on the whole, they tend to have a more conservative consumer base. Other than in Spain, the U.K. and a scattering of other countries, Europe hasn't seen the kind of housing boom in recent years as the U.S. underwent this decade. Eastern Europe seems to continue to be mired in some of the credit excesses they've been through in recent years.

IU: What do you see taking place in those markets where housing did spurt before the credit crisis?

Yardeni: Now that we've seen the housing bubble burst, economies that used to have very active real estate markets -- such as Spain, the U.K. and Ireland -- are going to slow even more.

IU: Which markets appear in relatively better shape in Europe?

Yardeni: France and Germany have been heavily reliant on exports. But they should show better strength than other European countries because a global recovery will provide a lift to their exporting capabilities. That should put them in a better relative position than Spain, Ireland and the U.K.

IU: What sort of chance to do you see for a turnaround in Japan?

Yardeni: Not much. The main hope for Japan is strong growth in China. They've got one of the worst demographic situations of any industrialized economy. And they don't have any real serious domestic demand. They're working on their second lost decade. Japan stands to lose much of their economic influence in the next decade.

IU: What about the U.S.?

Yardeni: This is going to be the first global recovery not led by the U.S. Our economy will recover, but it will be lackluster and take some time to complete. The good news is that the U.S. remains a very dynamic economy. We've still got plenty of entrepreneurs who are going to make money even with the government playing a larger role in the private sector. But even once employment growth builds, we still could be looking at a recovery about half the strength of what we've seen in the past.

IU: What other types of investments are you recommending to institutional investors these days?

Yardeni: Corporate bonds, junk bonds and leveraged loans all look interesting. If you can get involved in funds that invest in companies benefitting from TALF, those would seem to be an attractive way to invest right now. That's assuming that you think that we're on a course heading towards a global recovery. I certainly do, which makes me believe that some sectors considered at the moment to be more risky look very attractively priced. This would seem to be a good time to take advantage of some of those opportunities.

Comments

[User 305589:]

Let me get this right: He (rightfully, imho) says that America will see a slow and subdued recovery, as will Europe and Japan. So Chindia and Brasil will lead the way. Cool idea, but how could they? most of the much-hailed inner-Asia Trade so far has essentially been compoased of stuff that porceeded through various stages in various Asian countries to finally end up to be exported from China to japan, the USA and Europe. This, major, partwill obviously not rebound as long as these three economic areas do not recover substantially. So it's then all depending on some selected exports and Asian/Brazil domestic demand. Unfortunately, the emerging affluent middle class in Chindia and Brazil made their moneys to a large extent with exports to the developed nations and their income depends on it. And a rising oil price will again start to hurt the domestic economies of Chindia significantly.
So I really wonder where all that growth and recovery should actually come from? I hope Ed Yardeni doesn't think the 2 trn $ FX reserves of china will do the trick.
Imho his view, which I regard as the mainstream consensus view right now, will be in for a very rude awakening half a year or a year from now at the latest.

May 08 07:00 AM

[Liebold:]

Sounds a little to "cheery" to me, as well. But his oil call is OTM.

May 08 07:33 AM

[prairiedog555:]

So, if the economy is recovering, and inflationary pressure is a factor, why are bonds a good buy? Don't they go down when rates rise?

May 08 08:21 AM

[Henry Buttal:]

User 305589 - I think you are ignoring the potential for domestic consumption growth in the BRIC (and other) countries. Also, trade between the countries hasn't ceased, it has just dropped. The currently level of trade, while reduced almost to 10 year lows, will still offer enough to fund emerging markets, even if just at a slower pace.

May 08 09:27 AM

[Emerald:]

Inflationary pressure is two years down the road. We are currently in a deflationary mode with consumers and corporations looking to delever. Although interest rates will start to increase, the credit spread between Treasuries and corporate debt will decline as the economy improves and credit conditons improve. As a result, you will collect say 5-6% on investment grade corporate debt with the underlying value of the debt remaining relatively constant. Stay within a 4-6 year average duration for bonds and you should get equity like returns but higher up on the credit food chain. Note: Long AGG and Ginnie Mae bond funds.


On May 08 08:21 AM prairiedog555 wrote:

> So, if the economy is recovering, and inflationary pressure is a
> factor, why are bonds a good buy? Don't they go down when rates rise?

May 08 10:43 AM

[whidbey:]

In short, Ed sees both chance and opportunity. These people know how to make news, but little about investing. He lives alone in his shop of uncertainty and gives interviews based on who he once was. Ignore the man for gods sake.

May 08 06:16 PM

[RiskReturnO...:]

Probably an extra hedge with TBT will let you enjoy the spread compression and rising treasuries. This has worked very well in past few months, and I think it's got more to go.


On May 08 10:43 AM Emerald wrote:

> Inflationary pressure is two years down the road. We are currently
> in a deflationary mode with consumers and corporations looking to
> delever. Although interest rates will start to increase, the credit
> spread between Treasuries and corporate debt will decline as the
> economy improves and credit conditons improve. As a result, you will
> collect say 5-6% on investment grade corporate debt with the underlying
> value of the debt remaining relatively constant. Stay within a 4-6
> year average duration for bonds and you should get equity like returns
> but higher up on the credit food chain. Note: Long AGG and Ginnie
> Mae bond funds.

May 08 07:02 PM

[Old Trader:]

The point made was "junk bonds". You're correct in thinking that typically, when interest rates rise, previously issued bonds decline in value to reflect the current interest rate enviroment, but junk bonds are issued by companies whose prospects are bleak. A blossoming economy lessens the chances of those companies defaulting, resulting in a rise in the price/value of "junk bonds"...


On May 08 08:21 AM prairiedog555 wrote:

> So, if the economy is recovering, and inflationary pressure is a
> factor, why are bonds a good buy? Don't they go down when rates rise?

May 08 11:03 PM

[User 305589:]

I am not ignoring it at all - maybe I am underestimating it, yes that could be. I am not claiming to own the crystal ball. I do think, however, that the odds are heavily stacked against emerging markets domestic demand to lead the world economy into recovery mode. It's simply too small yet, to accomplish that job.
What is really striking is the magnitude and speed of the sentiment shift that has taken place. After almost Armageddon dears we are now back to speculations who will lead the next recovery.
I am more concerned with when this next recovery will start, how sustainable it will be once govt. stimulus runs out and how far to the upside it can carry and what it could do to unemployment and household incomes. If the latter two don't improve substantially, any expectation of a sustained recovery is premature. Unless, opf course, you regard a real gdp growth of 0-0.5% a 'recovery'


On May 08 09:27 AM Henry Buttal wrote:

> User 305589 - I think you are ignoring the potential for domestic
> consumption growth in the BRIC (and other) countries. Also, trade
> between the countries hasn't ceased, it has just dropped. The currently
> level of trade, while reduced almost to 10 year lows, will still
> offer enough to fund emerging markets, even if just at a slower pace.

May 11 03:52 AM

[Vinsanity:]

the only countries with strong population growth are India and Mexico (1.6% and 1.1% per yr, per JPMorgan), and both have <6% of the poulation oplder than 65. History shows that population growth has very long term effects on stoxk market returns (see Japan for the negative case with over 21% >65.)

So, the emerging markets may not need a US-led recovery.


On May 11 03:52 AM User 305589 wrote:

> I am not ignoring it at all - maybe I am underestimating it, yes
> that could be. I am not claiming to own the crystal ball. I do think,
> however, that the odds are heavily stacked against emerging markets
> domestic demand to lead the world economy into recovery mode. It's
> simply too small yet, to accomplish that job.
> What is really striking is the magnitude and speed of the sentiment
> shift that has taken place. After almost Armageddon dears we are
> now back to speculations who will lead the next recovery.
> I am more concerned with when this next recovery will start, how
> sustainable it will be once govt. stimulus runs out and how far to
> the upside it can carry and what it could do to unemployment and
> household incomes. If the latter two don't improve substantially,
> any expectation of a sustained recovery is premature. Unless, opf
> course, you regard a real gdp growth of 0-0.5% a 'recovery'

May 12 12:30 PM